Sweet Spot
How do you know when you’ve fully accessed market leverage in negotiating a lease extension? It’s when you find the sweet spot, a place in which the economics of the potential relocation lease match the lowest value the existing landlord is willing to offer. This is not a simple exercise of identifying the asking rents for alternative sites and asking the landlord to match. No, instead, it’s a byproduct of a carefully orchestrated negotiation that involves 2 main elements:
A multi-building negotiation with comparable buildings in which the tenancy is the subject of successive competitive bids by landlords seeking to win the deal.
A thorough analysis of the existing landlord’s cost/benefit in keeping the tenant at a steep discount to the “market” value it would otherwise achieve if securing a replacement tenant for the space.
The results of the competitive market process define the value for comparable space, while lending credibility to the possibility the tenant will choose to vacate the space -- an important consideration influencing how aggressive the existing landlord will be in the extension negotiations.
When sufficiently motivated by the competitive market process, the existing landlord will underwrite the cost/benefit of keeping its tenant compared to the alternative of finding a new tenant for the space. Indeed, the negotiation with the existing landlord should center around the assumptions it is making about securing a new tenant. These include the amount of time it will take to get the new tenant (downtime), the cost of tenant improvements required to secure the new tenant, and the rental rate it can achieve. For example, a landlord might value its space at $75/sf when the value we’re pushing for on an extension if $55/sf. Yet despite the big gap in rental rate, our $55/sf extension stands to generate as much (or even more) return for the landlord. How is this possible? Because of the market, specifically the amount of time it typically takes landlords to fill comparable vacancies, and the capital necessary to win a new tenant (tenant improvements). These are material considerations, having significant negative impact on the landlord’s return. A prudent landlord will accept a substantially reduced rental rate from the existing tenant because the lower rent extension generates more value and avoids risk.
This is how we access and exercise market leverage. It’s how we help our clients find the unique sweet spot that is the full market value of their tenancy, both in terms of its relocation options, and in terms of an extension of the existing lease.